Providing useful insights and making the complex world of energy more accessible, from an experienced industry professional. A service of GSW Strategy Group, LLC.

Wednesday, January 19, 2005

All Those Flares
A headline in the Financial Times today caught my eye: Shell Faces Penalties Over Flare Deadline, with the first paragraph going into the environmental damage caused by flaring. When you evaluate the situation carefully, though, there is both more and less here than meets the eye, besides additional bad publicity for Shell.

The basic issue is simple. The production of most oil is accompanied by varied quantities of natural gas. Historically, much of this was "flared", or burned off at the wellhead in what amounts to a giant candle. I recall hearing astronaut accounts of flares in Saudi Arabia being visible from orbit. It's easy to forget that for decades natural gas was considered a valueless byproduct, and flaring was the best and cheapest way to dispose of it.

You see very little oilfield flaring in developed countries, not just because pollution standards are stricter, but because the gas is closer to markets in which its value more than offsets the costs of gathering it up and sending it through a pipeline to heat homes and run factories and power plants. It can also be compressed and reinjected into the oilfield, to keep well pressures up and enhance production. The problem for Shell and other producers in Nigeria is that there is no handy domestic market to consume and pay for the gas, and the cost of reinjection doesn't always have sufficient offsetting benefits.

In the 1990s the Nigerian government passed regulations requiring all producers to cease flaring by 2008. This seems fairly proactive from an environmental standpoint, but the greenhouse gas properties of methane, the main constituent of natural gas, make this less obvious. Since methane is 21 times more potent in its global warming potential than carbon dioxide, the greenhouse gas that gets the most attention, burning it and turning it into CO2--thus cutting its impact on climate change by a 95%--is not necessarily the worst thing one can do with it.

What Nigeria gets out of all this is a chance to earn royalties on some additional production of gas that might not otherwise be counted, and some brownie points from the EU and non-governmental organizations that are most concerned with climate change. In the process, the oil companies incur some additional production costs, and they are effectively forced to aggregate all this gas and do something useful with it in the market, either as LNG or using gas-to-liquids technology to convert it to clean diesel fuel. Along the way, they will generate some greenhouse gas offsets they can either trade or apply to their emissions elsewhere. None of this is bad, unless you think a difference of a percentage point or two in project economic returns, and ultimately in shareholder value, is awful.

While putting an end to flaring seems like a no-brainer, it is much more complicated and somewhat less beneficial than one's intuition might suggest.